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CORE Unit7 The firm and its customers :pencil2: (Monopoly: a firm that isโฆ
CORE Unit7 The firm and its customers :pencil2:
Maximising profit - isoprofit curves -> these two trade-offs balance at the profit-maximizing choice of P and Q
Marginal rate of transformation (MRT): the quantity of some good that must be sacrificed to acquire one additional unit of another good. At any point, it is the slope of the feasible frontier
The demand curve is the feasible frontier, and its slope is the marginal rate of transformation (MRT) of lower prices into greater quantity sold
Marginal rate of substitution (MRS): the trade-off that a person is willing to make between two goods. At any point, this is the slope of the indifference curve
The isoprofit curve is the indifference curve, and its slope is the marginal rate of substitution (MRS) in profit creation, between selling more and charging more
The large firm produces its output at lower cost per unit
Technological advantages: large-scale production often uses fewer inputs per unit of output
Economies of scale: these occur when doubling all of the inputs to a production process more than doubles the output
Specialisation
Engineering reasons
Diseconomies of scale: these occur when doubling all of the inputs to a production process less than doubles the output -> the Dilbert law of firm hierarchy
Cost advantages: in larger firms, fixed costs such as advertising have a smaller effect on the cost per unit. And they may be able to purchase their inputs at a lower cost because they have more bargaining power
Happens if a fixed cost doesn't depend on the number of units, e.g. marketing expenses
Large firms are able to purchase their inputs on more favourable terms
Demand advantages: benefits from selling the products, this occurs when people are more likely to buy a product or service if it already has a lot of users
Network economies of scale: these exist when an increase in the number of users of an output of a firm implies an increase in the value of the output to each of them, because they are connected to each other, e.g. in technology-related markets
Marginal cost
The additional cost of producing one more unit of output, which corresponds to the slope of the cost function
The marginal cost is equal to the slope of the cost function at the point
Economies of scope: cost savings that occur when two or more products are produced jointly by a single firm, rather being produced in separate firms, e.g. graduate education, undergraduate education and research
Differentiated product: a product produced by a single firm that has some unique characteristics compared to similar products of other firms
Willingness to pay (WTP): an indicator of how much a person values a good, measured by the maximum amount he or she would pay to acquire a unit of the good
Economic profit = total revenue โ total costs = ๐๐ โ ๐ถ(๐) (including the opportunity cost of capital) = ๐(๐ โ AC)
Normal profit = the rate of profit is equal to the opportunity cost of capital (the payments that must be made to the owners to induceๅผ่ช them to hold shares)
Profit margin: the difference between the price and the marginal cost
Slope of isoprofit curve = โ (๐ โ MC) / ๐ = โ profit margin / quantity
Constrained optimisationๆไฝณๅ: constrained choice problem is how we can do the best for ourselves, given our preferences and constraints, and when the things we value are scarce
A decision-maker chooses the values of one or more variables
to achieve an objective
subject to a constraint that determines the feasible set
The profit maximising point is where marginal revenue (MR) = marginal cost (MC)
Surplus and profit
Producer surplus is closely related to the firmโs profit, but it is not quite the same thing. Producer surplus is the difference between the firmโs revenue and the marginal costs of every unit, but it doesnโt allow for the fixed costs, which are incurred even when Q = 0
Profit is the producer surplus minus fixed costs
Consumer surplus is a measure of the benefits of participation in the market for consumers
Pareto
Pareto improvement: a change that benefits at least one person without making anyone else worse off
Pareto efficient: an allocation with the property that there is no alternative technically feasible allocation in which at least one person would be better off, and nobody worse off
Price elasticity of demand: he percentage change in demand that would occur in response to a 1% increase in price. We express this as a positive number. Demand is elastic if this is greater than 1, and inelastic if less than 1 -> ๐=โ (% change in demand) / (% change in price)
The elasticity changes as we move along the demand curve, even if the slope doesnโt / When the elasticity is higher than 1, MR > 0. When the elasticity is below 1, MR < 0 -> Elasticity = (โ ๐ / ๐) ร (1 / ๐ ๐๐๐๐)
The lower the elasticity of demand, the more the firm will raise the price above the marginal cost to achieve a high profit margin
Using demand elasticities in government policy
If demand is highly elastic, a tax will cause a large reduction in sales
If a tax causes a large fall in sales, it also reduces potential tax revenue
Monopoly: a firm that is the only seller of a product without close substitutes. Also refers to a market with only one seller
Pareto-inefficient allocation is a case of market failure
Monopoly rents: a form of economic profits, which arise due to restricted competition in selling a firmโs product -> market power
Cartel: a group of firms that collude in order to increase their joint profits (to keep the price high), e.g.OPEC
Competition policy: government policy and laws to limit monopoly power and prevent cartels
Natural monopoly: a production process in which the long-run average cost curve is sufficiently downward-sloping to make it impossible to sustain competition among firms in this market, e.g. water, electricity, gas